Ares Capital Corp Q3 FY2024 Earnings Call

Thank you. Let me start with some important reminders. Comments during the course of this conference call and webcast and accompanying documents contain forward-looking statements and are subject to risks and uncertainties. The company's actual results could differ materially from those expressed in such forward-looking statements for any reason, including those listed in its SEC filings. Ares Capital Corporation assumes no obligation to update any such forward-looking statements. Please also note that past performance or market information is not a guarantee of future results. During this conference call, the company may discuss certain non-GAAP measures as defined by SEC Regulation G, such as core earnings per share or core EPS. The company believes that core EPS provides useful information to investors regarding financial performance because it's one method the company uses to measure its financial condition and results of operation. A reconciliation of GAAP net income per share of the most directly comparable GAAP financial measure to core EPS can be found in the accompanying slide presentation for this call. In addition, a reconciliation of these measures may also be found in our earnings release filed this morning with the SEC on Form 8-K. Certain information discussed in this conference call and the accompanying slide presentation, including information related to portfolio companies, which derive from third-party sources and has not been independently verified. And accordingly, the company makes no representation or warranties with respect to this information. The company's third quarter ended September 30, 2024, earnings presentation can also be found on the company's website at www.arescapitalcorp.com by clicking on the third quarter 2024 earnings presentation link on the homepage of the Investor Resources section of the website. Ares Capital Corporation's earnings release and Form 10-Q are also available on the company's website. I'll now turn the call over to Mr. Kipp DeVeer, Ares Capital Corporation's Chief Executive Officer. Kipp?

Thanks a lot, John. Hello, everyone, and thanks for joining our earnings call today. I'm here with our Co-President, Kort Schnabel, and our newly appointed Co-President, Jim Miller; Jana Markowitz, our Chief Operating Officer; Scott Lem, our Chief Financial Officer; and other members of the management team will also be available during our Q&A session. Before discussing our third quarter results, I want to recognize the leadership changes that we announced this morning. As I mentioned, Jim Miller will now join Kort Schnabel as a Co-President of ARCC. And by way of background, Jim joined Ares in 2006 and currently serves as a co-head of our U.S. direct lending strategy and as a member of our Investment Advisors Investment Committee. Jim has been one of the key contributors to the success of ARCC and the Ares Direct Lending platform and we look forward to having him play an even more prominent role in this company's direction in the years ahead. As part of this change, Mitch Goldstein is stepping down as Ares Capital's Co-President, but he is joining Ares Capital's Board where he and Michael Smith will serve as Co-Chairman, which will also continue to lead Ares' Global Credit Group as a co-head. And as part of this transition, Michael Arougheti will relinquish his role as Chairman but remain a Director of the company. This transition demonstrates the depth and tenure of our team and the continued evolution of our company and its success over a long period of time. With that, let me now turn to the third quarter results. This morning, we reported another quarter of strong core earnings of $0.58 per share and another quarter of record NAV per share of $19.77. As we've discussed in the past, we believe we are well positioned to what we expect will be a more active deal environment in the future, driven by expanding M&A and sponsor activity as private equity managers are benefiting from lower rates while at the same time feeling growing pressure to return capital to their investors. In the third quarter, we saw a further increase in overall M&A volume with an acceleration in sponsor-backed transactions in particular. Against this backdrop, direct lenders have continued to finance a high percentage of new leverage buyouts, specifically representing about half of the loan volume supporting buyouts in the third quarter. We believe that Ares is well positioned to take advantage of this environment given our deep and long-standing sponsor relationships and our focus on strategic transactions in defensive industries with strong secular trends. Due to our strong competitive position and a more active investing environment, we saw meaningful year-over-year growth in both transactions reviewed and new commitments during the third quarter. Specifically, we reviewed nearly 30% more transactions compared to the same period last year, resulting in an estimated $155 billion in quarterly deal volume reviewed. For context, this amount exceeded the completed transaction volume reported for the entire broadly syndicated leveraged loan market for the quarter. Our long-held approach of sourcing as many transactions as possible is a key factor in remaining highly selective, which we believe ultimately results in strong long-term portfolio performance. Our ability to grow with our existing portfolio of companies that we know well is another key factor in our high level of selectivity, further reducing underwriting risk and driving stronger credit performance. This advantage supported our loan growth in the third quarter as over 75% of our new commitments were to incumbent borrowers. We believe the growing trend of existing portfolio companies consolidating their financing relationships with us is an encouraging trend. We also added 23 new companies to the portfolio, bringing our highly diverse portfolio to over 530 companies. Ares Capital's strong credit profile can be seen in the health and performance of our portfolio companies. Our nonaccrual rates declined quarter-over-quarter and remain at levels well below industry averages and the fair value of our risk-rated 1 and 2 loans also declined from the second quarter. Further underscoring the consistent health of our borrowers, the LTM EBITDA growth of our portfolio companies remained in the low double digits for the third consecutive quarter. And finally, as Scott will discuss in more detail, the right-hand side of our balance sheet continues to support our investing activities and remains a competitive advantage. You've seen that we were recently upgraded by Moody's to a higher investment-grade notch which we believe further solidifies Ares Capital as the highest rated company in our sector by all three major rating agencies. With moderate leverage just over 1x debt to equity and well over $5 billion in available liquidity, incorporating post-quarter-end financing activities, we believe we have significant financial flexibility and leading access to efficient forms of capital. With that, let me turn the call over to Scott to provide more details on our financial results and some further thoughts on the balance sheet.

Thanks, Kipp. Let me walk through our income statement before discussing our balance sheet and the actions we took during the quarter to enhance our capital position. This morning, we reported GAAP net income per share of $0.52 for the third quarter of 2024 compared to $0.52 in the prior quarter and $0.89 in the third quarter of 2023. We also reported core earnings per share of $0.58 for the third quarter of 2024 compared to $0.61 in the prior quarter and $0.59 in the third quarter of 2023. Overall, our total investment income increased compared to the prior quarter, largely due to higher interest and dividend income from net portfolio growth, offset by lower restructuring fees as the majority of the new commitments during the quarter were with existing portfolio companies. In terms of our expenses, the increase in our interest and credit facility fees was consistent with our higher leverage during the quarter to fund a portion of our portfolio growth. Our total portfolio at fair value at the end of the quarter was $25.9 billion, up from $25 billion at the end of the second quarter. The weighted average yield on our debt and other income-producing securities at amortized costs was 11.7% at September 30, which was down from 12.2% at June 30 and 12.4% for the same period a year ago. Our total weighted average yield on total investments at amortized cost was 10.7% which compares to 11.1% a quarter ago and 11.2% from a year ago. The declines in our yields were largely due to reduced base rates and, to a lesser extent, spread on new investments. Our stockholders' equity ended the quarter at $12.8 billion or $19.77 per share, another record high for us, as Kipp noted earlier in the call. Before discussing our capitalization and liquidity, let me start by highlighting the notable accomplishment Kipp mentioned related to our credit ratings. At the end of September, Moody's upgraded the long-term issuer and senior unsecured rating for Ares Capital to Baa2 from Baa3. In addition to being rated investment grade by all three of the major rating agencies, we now have two of our three ratings firmly mid-BBB. We believe this should lead to even more efficient funding costs and potentially increase debt capacity over time. These ratings further distinguish Ares Capital, not only within the BDC sector but also among a select universe of firmly BBB or higher-rated public companies in the U.S. Within the BDC sector, we are the only BDC that has both the highest credit ratings from all three major agencies and positive outlooks from S&P and Fitch. In terms of our recent debt capital activity, we amended our revolving funding facility, which included extending the end of the reinvestment period and the maturity to a full three and five years, respectively, and upside in the facility from $1.78 billion to $2.15 billion. We also announced that we priced our second on-balance sheet CLO for ARCC, which we expect will close next month subject to customary closing conditions. This closing will bring an additional $544 million of low-cost secured debt capital priced at SOFR plus 158 basis points. We're happy to continue both diversifying and lowering the weighted average cost of our debt capital and believe CLO financing can continue to be a nice addition to our debt capital going forward. Lastly, as we discussed on our last earnings call, earlier in the third quarter, we amended our SB funding facility, where we extended the reinvestment period and maturity each by more than one year, upsized the facility from $865 million to $1.3 billion and reduced the drawn spread by 40 basis points. In total, pro forma of all these transactions since June 30, we have added over $1.3 billion of new debt capacity and reduced the weighted average spread of our committed floating rate debt capital. Our overall liquidity position remains strong with nearly $5.8 billion of total available liquidity, including available cash on a pro forma basis for the post-quarter end activity that I just highlighted. We also ended the quarter with a debt-to-equity ratio net of available cash of 1.03x. We believe our significant amount of dry powder positions us well to continue supporting our portfolio company commitments and new investing activities. Moving on to the dividend. We declared a fourth quarter of 2024 dividend of $0.48 per share. ARCC has been paying stable or increasing regular quarterly dividends for over 61 consecutive quarters. This dividend is payable on December 30, 2024, to stockholders of record on December 13, and is consistent with our third quarter 2024 dividend. In terms of our taxable income spillover, we finalized our 2023 tax returns and are happy to report that we ended 2023 with approximately $631 million or $1.04 per share available for distribution to stockholders in 2024. In addition to our third quarter core earnings being well in excess of our current dividend, the spillover level is more than twice our current regular quarterly dividend, which we believe is a significant differentiator for us in the BDC sector and helps provide further visibility and stability to our dividend in a potentially declining rate environment. I will now turn the call over to Kort to walk through our investment activities.

Thanks, Scott. I'm now going to spend a few minutes providing more details on our investment activity, our portfolio performance and our positioning for the third quarter. I will then conclude with an update on our post-quarter-end activity and backlog. In the third quarter, our team originated approximately $3.9 billion of new investment commitments across 74 different transactions. Excluding the $670 million of loans we originated and distributed as agents, our new investment commitments more than doubled year-over-year, reflecting the strength of our platform and a more active overall M&A market. Our level of originations also reflects our growing market share with our existing borrowers, as Kipp discussed previously. Evidencing this trend, our share of the overall financings for our top 10 largest incumbent commitments in the quarter more than doubled. Shifting to our portfolio. We ended the third quarter with a $25.9 billion portfolio at fair value, which grew 4% from the prior quarter and 18% from the prior year. In addition to our expanding market share with incumbent borrowers, our growth is supported by our ability to provide flexible capital solutions to a wide variety of new companies seeking a direct lending solution. This can be seen in the total number of companies in our portfolio, which reached 535 in the third quarter and increased 9% year-over-year. Further underscoring our focus on covering the broader middle market, the median EBITDA of the borrowers in our portfolio was $82 million in the third quarter, with approximately one-third having less than $50 million of EBITDA. As Kipp mentioned, our portfolio companies remain healthy, and credit performance remains strong. Our weighted average portfolio grade of 3.1 remained unchanged from the prior quarter's level. Our nonaccruals at cost ended the quarter at 1.3%, representing another 20 basis points decline from the prior quarter and is within 50 basis points of our lowest level in the last decade. Our current nonaccrual level remains well below our 2.8% historical average since the great financial crisis and the BDC historical average of 3.8% over the same time period. Our nonaccrual rate at fair value also decreased to 0.6% from 0.7% last quarter, which continues to be well below historical levels for us as well. Further underpinning the strength of our portfolio, at the end of the third quarter, the weighted average loan-to-value in the portfolio was 43%, which we believe provides us with strong downside protection for our loans. This loan-to-value is also significantly below our 10-year average. When looking at performance by company size, it is noteworthy that company size continues to not be a driver of performance as companies in all size bands in our portfolio had similar EBITDA growth rates over the last 12 months. In our view, our underwriting and portfolio management processes and our ability to select what we believe are the best companies in attractive industries drives these results. It is also noteworthy that to further our advantages and to support our broad middle market coverage, Ares Management acquired Riverside Credit Solutions during the third quarter. Riverside is a well-established, lower middle market-focused firm managed by a team that we have known for a long time with a very strong investing track record. We believe this team is additive to Ares' direct lending platform's coverage in this important part of the market. As we discussed in detail at our Investor Day in June, we believe Ares is the only direct lending platform at scale that actively focuses across the lower, middle, and upper middle markets. This differentiated coverage approach supports our ability to focus on market segments that offer better risk-adjusted returns while remaining highly selective. Across our markets, we have seen credit dispersion start to emerge with certain other managers experiencing growing and elevated levels of nonaccruals. We continue to believe the merits of our many competitive advantages are driving differentiated results as diversification and industry selection have contributed to ARCC's strong credit performance in comparison with other BDCs. Through our time-tested underwriting processes and collaborative culture, our highly selective approach to investing and focus on incumbent borrowers as a differentiated opportunity for growth, we have been able to avoid many of the problems that have driven recent nonaccruals in the BDC space. Another point of differentiation for ARCC versus other BDCs is our high level of portfolio diversification. By maintaining small individual company position sizes of less than 0.2% of the portfolio on average, ARCC has been able to mitigate the impact of negative credit events in any one company or industry. Finally, let me highlight our active start to the fourth quarter. From October 1 to October 24, 2024, we made new investment commitments totaling $408 million of which $320 million were funded. We exited or were repaid on nearly $1.2 billion of investment commitments, which resulted in us earning $4 million of net realized gains. As of October 24, our backlog stood at roughly $2.8 billion, more than triple the level one year ago. Our backlog contains investments that are subject to approvals and documentation and may not close or we may sell a portion of these investments post-closing. I will now turn the call back over to Kipp for some closing remarks.

Thanks so much, Kort. So let me just take an opportunity to share a few thoughts on our past and our future. As many of you know, we're celebrating the company's 20th anniversary this month. Over the course of our 20-year history, my partners and I have seen the growth of direct lending evolve from a small handful of BDCs competing with banks for their lower middle market loans to a proven industry with real institutional backing and recognition. During this time, we've continued to refine our processes, grow our team and leverage some new thinking. However, we've remained consistent in our approach, our investment philosophy and our focus on the team and our culture, which underpin everything that we do. Our third quarter earnings and credit results build upon our 20-year track record of successfully managing the company throughout a wide variety of economic and market cycles. Over the past two decades, Ares Capital has made nearly 4,000 investments with a cumulative net realized loss rate of 0% and at an asset level realized gross IRR of approximately 13%. And over the same time period, our shareholders have been rewarded having enjoyed an average annual total return of roughly 13%, which represents outperformance of over 225 basis points per year for the S&P 500 Index. Needless to say, we're very proud of this performance. Looking forward, we believe Ares Capital and its competitive advantages remain strong. With the declaration of the fourth quarter dividend, ARCC's regular quarterly dividend has been stable, we're growing now for more than 15 years, and we remain confident in our ability to maintain this dividend level in the foreseeable future even in the face of lower expected interest rates. Furthermore, should market interest rates decline, we believe the value of our attractive dividend yield that is well covered by core earnings and supported by a strong level of spillover income will become even more valued by equity investors. As we look to the future, we believe the company remains very well positioned to address what we see as a growing market opportunity. And the management team and the Board remain committed in continuing to build upon what we believe is a successful long-term track record. As always, we appreciate you joining the call today. We look forward to speaking with you next quarter. And with that operator, we'd like to open the line for questions.

Congratulations on the 20th anniversary, very cool. The entire market has been discussing the potential for rates to stabilize or possibly decrease, which might boost confidence in the economy and create a significant wave of private equity that needs to be addressed. You've experienced a couple of strong quarters of investment activity, and it appears that the pipeline is looking promising. Are we now entering that phase of the market? Does this suggest that you're preparing for a highly active 2025, or is it too soon to determine?

I appreciate the comment, John. The last two quarters have been good, and the simple answer is yes, we remain quite busy. I believe getting the election behind us will help, and as we approach year-end, I expect a busy year next year for sure.

Yes. It’s Kort. I can jump in on that. I wouldn’t say it’s a slightly different asset class. I think the takeaway is Riverside is a very active lower middle market lender. It’s not a large team. It’s a 9-person team. We’ve known them for a really long time. And we have immediately integrated them into our team and our process, and they’re going to help us energize and double down on our commitment to cover the lower middle market even as we scale. And I think we’re excited to have them on board. They’re going to bring deals to our investment committee just like any of our other 200 investment professionals. And it should be a good thing for our broader market coverage.

On the market opportunity for the asset class. So today, we have a lot of spread compression and hopefully, volume heals and relieves that dynamic. But we wanted to ask your view in light of all the capital being raised if the direct lending premium is on more of a secular decline?

I don't think so because the way that the market works typically is folks lock up capital in illiquid credit when they look at other reference securities in liquid credit, in particular, and frankly, other surrounding markets, right? So the risk premium, the complexity premium that we get for locking up investor capital on illiquid credit, of course, varies over time, right? If you look at historical numbers, it's somewhere between 150 and maybe 400 basis points. But for me, it's that relationship that really needs to remain in place for the capital to continue to support growth in the market. I think your point on spread compression is fair and it's there, but it's in response, not so much to lack of deal flow, but just I think to most of our teams as well as some of our competitors believe that the economy is in a better place than we might have expected to fall through very low. There's growth. And when you see less risk investing in a market, you're willing to take less return. And that's what's happened over the last year or two.

That's very helpful. If I can do a small follow-up on Riverside, just seeing how perhaps one-off that was or if maybe this is indicative of another large trend where large managers such as yourselves are able to consolidate and add on a lot of sort of investment origination capacity that way amongst the perhaps likely sprawling lower middle market firms out there.

Yes. I mean, all I'd say is something that I can add on to what Kort said, which is really the meat of the bone or the meat on the bone. Look, I mean, we've been at this 20 years, and the key is that you continue in our experience to build the best origination team you possibly can, which leads to the best outcomes. So we've been adding people in a whole host of different segments and industries and all of that for 20 years. Riverside is just another example of that, right? It's, as Kort mentioned, a lower middle market team that can add to what we're doing, and it remains our commitment to keep adding things that we think bring value to the company and the shareholders.

And Fin, as you know, we’ve talked a lot about our ability to cover all different parts of the market. And I think, again, this is just a reiteration of our commitment to that lower than the market. I think it might be natural for us as we scale to potentially take our eye off the ball or focus a little less on that part of the market. And I think we want to make sure that we are intentionally not doing that both with our existing team as well as adding resources here through the acquisition of Riverside. So hopefully, that helps.

Congrats to everyone with a new or expanded role with the company. I was hoping to follow up on the comments about growing share with existing clients and as they sort of consolidate relationships. I assume that, that involves a good amount of refi activity that happened within the portfolio? Is that the case in the third quarter? And do have sort of a view on what that could look like going forward?

I mean, not really necessarily unless I think the point is we've got a very, very diverse set of clients, right? I mean, the company today literally has representation with 200-plus sponsors, and that doesn't even take into account industry groups and nonsponsored deals and all of that stuff. But look, the key is that we keep doing more with the folks that we want to do more with. And I think that the large players with big teams have been able to continue to capture more and more share with the most relevant clients. It's not just us, it's others. But the focus is there. It's not needing to be heavier on refi activity in our minds.

Yes. And in fact, I would say it's not a lot of refi activity. It's a lot of add-on capital activity into our existing portfolio companies to support growth in M&A. And the fact of the matter is we are providing more of that add-on capital than our other club members in those facilities, which is what's contributing to our market share gain. So it's definitely more of that and less refinancing.

I think it was a pretty good quarter. I mean, comes and goes, unpredictable from quarter to quarter. But I don’t think there’s anything other than just circumstance and randomness.

Happy anniversary. I noticed that your second lien exposure over the last three years has been reduced by more than half, so I'm wondering if we have been following a defined internal strategy during this time, or if this change is more related to the overall shifts in the private credit industry.

Yes, I can respond to that. What we're observing is a shift in the market that is currently taking place. It's not necessarily an intentional change on our part. We're seeing an increase in unitranche transactions, which are gaining market share from the second lien market. Our focus is on finding good relative value across different market conditions and capitalizing on the opportunities available to us. We appreciate the returns we are achieving with first lien assets, and leverage levels remain below average while returns are higher. Therefore, we believe it's a favorable area for investment, but we will continue to monitor how the market evolves moving forward.

Congratulations to everyone on their new roles. I have a couple of questions primarily regarding your spreads and yields. Scott mentioned in his prepared remarks that a significant portion of the decline in the weighted average yield this quarter was due to base rates. Have you noticed any changes in the choices being made, or should we anticipate a shift towards shorter-term options like 1 month if rates begin to drop, as opposed to 3 months, or when the reset dates occur? It seems that normally, new month resets at the start of the quarter wouldn’t have had such a considerable impact this quarter. For the fourth quarter, yes, but could you provide any insights on this?

Yes. The comment about the decline in yields refers to those yields we disclosed being at the end of the period. The effects of that won't really be felt until the following quarter. Regarding the resets, it will vary depending on the borrower. Typically, they occur at the end of the month, but we haven't observed any shift yet in the terms of the contracts from three months to one month, mainly because the rates have only recently changed.

I want to emphasize the impact by providing some figures. There has been a 70 basis point decline over the last three months, from Q2 to Q3. We have observed about 10 basis points of that reflected in the Q3 numbers, which is due to a lag effect. The full effects of the base rate decline have not yet been fully realized this quarter. It's important to note that in our disclosure, we indicated that every 100 basis point reduction leads to a $0.03 decrease in our quarterly earnings. The positive takeaway is that there is a significant buffer regarding our dividend, which was a deliberate strategy because we anticipated a decline in rates. Our experience navigating various interest rate environments gives us confidence in continuing to do so.

Got it. Regarding the current quarter, it appears that newly onboarded portfolio companies for first lien spreads were below 500 basis points. You've mentioned spread compression previously, and this seems to be the lowest level observed in a decade. Is there something particular about this quarter, or is the spread compression not only present but also worsening? Could you share your insights on this?

Yes. I believe the spreads have contracted by at least 100 basis points this year, moving from the start of the year towards its conclusion. There are a number of large-cap unitranches being completed with vigor, but middle market deals are not experiencing the same level of activity. I would characterize the market generally in the range of 450 to 550 basis points, depending on credit quality, company size, and other factors. When you factor in the base rate along with the spread and fees, it still results in a fairly attractive gross unlevered return on the asset, in our opinion. As I mentioned earlier, when the economy shows strength and the portfolio is performing well, entities, including Ares, are comfortable with seeing a modest decline in returns. We anticipate this trend, and I don’t foresee it persisting.

Well, that’s an important point, which is I think that they have actually stabilized. We did see spreads stabilize this past quarter relative to the prior quarters where there was consistent decline. So I think that’s an important point. And then Kipp’s point around looking at the absolute return, again, relative to our historical experience, we’re still getting 10% on senior debt at leverage levels that are well below historical averages. So I think on an absolute basis, we’re still feeling pretty good.

Moving on, we'll take our next question from Kenneth Lee with RBC Capital Markets.

Just in terms of the portfolio there, it looks like average interest coverage ratios ticked up to 1.8x. Just wondering, do you still expect a pickup in terms of credit losses across the industry? Or are things just getting much better, especially with the potential rate outlook there?

I was forecasting, frankly, the things would get worse than they've gotten. I mean, I see it currently as stable, right? You have very low nonaccruals as a percentage of the portfolio, both on a fair value and cost basis. When we look at sort of the watch list names, 1s and 2s, again, the count has been pretty consistent. So at this point, for me, it's a little bit difficult to predict. I guess, we'll see what the economy does, and we'll see what the trajectory of rate decreases likely are. But I see it as a pretty stable picture. I don't see an increase in defaults. I don't see things also materially getting much better than this. They're pretty good from a credit quality perspective today when you look against the historical numbers.

Got you. And then just in terms of just a little bit of housekeeping. Any color around amendment activity you've seen in the quarter? And as well, any kind of revolver facility drawdowns that you want to highlight?

I’ll just say, amendment activity has been very stable, if not even a little bit lighter than normal. And then on the revolver draw point, revolver drawings – revolver draws at our portfolio companies have actually gone down this quarter versus prior quarter. So liquidity and our borrowers feel healthy.

Exits in the fourth quarter, there was a chunk that went over to Ivy Hill, but it looked like the net activity was still negative. How do you see that playing out for the full quarter?

Yes. I believe you're referring to the activity that took place after the quarter ended, which lasted for 24 days. It's not something I would overanalyze. As you noted, $450 million of the exits were sales to Ivy Hill. While it's important to recognize that we still have a net negative number, we are encouraged by the backlog we've disclosed, which is around the mid-$2 billion level, and we feel positive about the level of activity in the market.

Understood. Regarding the improvement in interest coverage, was that mainly due to the lower portfolio yield, or is there an improvement in EBITDA as well? I believe EBITDA was slightly down sequentially, but that could be misleading.

We saw EBITDA growth in the portfolio and slightly lower rates for portfolio companies.

Yes, the growth rate of EBITDA was down sequentially from 12% to 10%, but still 10% growth, which will help with the interest coverage math as well as the modest rate declines.

It's really difficult to come in after 20 years and improve something that's been run this well. That is...

You've been here for, what, 18 of the 20?

Yes, the first two years, I was not here, so they can take full credit on it. But no, I’m very excited to be part of the team, close to working with ARCC, but it’s – this is a great business with a great team. So nothing exciting from my end.

Congrats on 20 years as well as the upgrade. On the spread compressions that you've kind of seen this year, has that also impacted structuring fees at all for new deals? Or is it just maybe a little too early to tell just given we're still kind of waiting on M&A recovery?

I mean, I think you have to take it all together and say borrowers are looking at the all-in cost of financing fees, the base rate and obviously, spreads. A little bit of pressure on fees, too, the same way we've seen some pressure on spreads. We'll see where it goes from here. I don't think we have anything to take away quite yet. It's been fully exited from the portfolio. We think it’s moderated a lot. I mean, if you follow us from quarter-to-quarter, it has been a theme that we actually had talked about and something that was very evident in our portfolio as far back as probably the third, fourth quarter of ‘21 as we sort of emerged from that difficult period with the pandemic, it continued and it was quite persistent. But I would say this year, even in the last year, it’s moderated quite a lot to levels that feel much more normalized on a go-forward basis.

Reiterate the congratulations on the successful 20 years. My question has to do with PIK. So it's been stable at about 15% of revenue the past few quarters. So the first part of my question is, do you think PIK has peaked at these levels? And more importantly than that, what percentage of PIK was just temporarily built into the original deal to kind of give the borrower some additional flexibility versus kind of PIK related to any sort of borrower liquidity issues?

Yes, thank you, Derek. As you might know, we engage in a significant amount of junior capital investing and believe we excel in this area. Part of our strategy, especially in a high-interest-rate environment, involves structuring deals that include PIK components. This approach allows us to secure business in various situations. We focus on high-quality companies that are adjusting to the higher rate environment and have less cash available. To answer your question, most of the PIK income we generate is a strategic choice, not a result of underperformance by portfolio companies, which is quite different from our experience in 2000 when most PIK income was due to companies struggling to generate cash. In the business development company sector, PIK income is prevalent, and we closely analyze its significance. For this quarter, the percentage of our total interest and dividend income from PIK has decreased notably compared to 2020, 2021, and 2022. Therefore, I am not particularly concerned about it now, as most of this PIK income aligns with our investment philosophy and has contributed to our impressive return on equity relative to our competitors.

And we actually did disclose at our Investor Day, and it still holds true today, 90% of our PIK income was structured at the time of the investment versus only 10%, which is amendment oriented PIK.

Yes, we do a fair amount of junior capital investing, and we think we do quite well with it. A portion of that is particularly in a higher interest rate environment with PIK components. That's why we win business in many of these circumstances. We are doing these in high-quality companies that simply are adjusting to a higher rate environment and having less cash on hand. Most of the PIK income is by choice, not a concession for underperformance. In terms of inflation, what are your observations regarding the portfolio? It seems that we have passed the worst points of inflation, but it remains persistent. The story doesn't seem to completely fade away, and I'm curious about the implications of a higher inflation outlook given the potential outcomes of the election. We think it’s moderated a lot. I mean, if you follow us from quarter-to-quarter, it has been a theme that we actually had talked about and something that was very evident in our portfolio as far back as probably the third, fourth quarter of ‘21 as we sort of emerged from that difficult period with the pandemic, it continued and it was quite persistent. But I would say this year, even in the last year, it’s moderated quite a lot to levels that feel much more normalized on a go-forward basis.

We'll take our first question from John Hecht with Jefferies.